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The Politics of Private Foreign Investment

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The unique role of the United States in the world economy arises not from the fact that it is by far the largest trading nation but from the importance of the Government's payments abroad and the magnitude of U.S. private foreign investment. In 1966, the Government provided $4.6 billion in economic aid and foreign credits, and military expenditures abroad were $3.6 billion (apart from military aid), while the outflow of private capital was close to $4 billion. It is clear enough that the international transactions of the U.S. Government are essentially of a political character, although they have important economic effects on this country and the rest of the world. What is not so clear is that there are political aspects to our private foreign investment-not because it is motivated by foreign policy considerations, but because foreign countries are concerned about its impact on their economic and foreign policies. This is inevitable, given the magnitude of these investments and their role in the economies of the countries in which they are made.

The private foreign investments of the United States now have a book value of over $86 billion. Last year they yielded a net income of about $7.0 billion of which about $5.6 billion was remitted to the United States and about $1.4 billion was retained by the foreign subsidiaries as undistributed profits. In addition, over $1 billion was remitted in fees and royalties. The true market value of U.S. private foreign investments, as indicated by a conservative capitalization of the income, must be well in excess of $100 billion. (See Table I, next page.)

In 1963 and 1964, net new private foreign investment reached $4.46 billion and $6.52 billion respectively. In the past two years, because of substantial restraint on U.S. foreign investment through the program of voluntary guidelines and the Interest Equalization Tax, which deterred investors from pursuing higher interest rates abroad, the totals fell to $3.69 billion in 1965 and $3.91 billion in 1966. Apart from new issues of foreign bonds, virtually all U.S. foreign investment in the past two years has been direct investment-that is, in branches and subsidiaries of U.S. companies abroad. The book value of such investments is now about $54 billion (1966 estimated). At the end of 1965, the last year for which such data are available, about 60 percent of this was in Canada and Europe, about 20 percent in Latin America and other Western Hemisphere countries, and about 20 percent in the rest of the world. By industries, nearly 40 percent of U.S. foreign direct investment is in manufacturing, over 30 percent in petroleum; the rest is widely distributed in trade, mining and smelting, and miscellaneous enterprises. (See Table II.)

The political problems arise almost entirely from U.S. direct investment; what complaints other governments may make with respect to portfolio investment and credits generally have to do with their alleged inadequacy. The ownership of foreign securities and the granting of foreign credits are largely passive in nature; they involve very little U.S. influence on production, employment and trade in foreign countries. On the other hand, direct investment is by its nature a part of the economies of foreign countries. Not surprisingly, it gives rise to problems that are political as well as economic in character.

I. VALUE OF U.S. PRIVATE INTERNATIONAL INVESTMENT AND REMITTED INCOME

(in billions of dollars) Remitted earnings: Year Total private Fees and end investment Direct Securities Other Income royaltiesa

a From direct investment enterprises only. e Estimated. Source: Survey of Current Business (Dept. of Commerce), September 1966, p. 40, adjusted for 1966.

II

The role of U.S. direct investment in the world economy is staggering. According to the U.S. Council of the International Chamber of Commerce, the gross value of production by American companies abroad is well in excess of $100 billion a year. That is to say, on the basis of the gross value of their output, U.S. enterprises abroad in the aggregate comprise the third largest economy (if such a term may be used to designate these companies) in the world-with a gross product greater than that of any country except the United States and the Soviet Union. Of course, these enterprises are large users of raw materials and components produced locally, so that their contribution to the net product (value added) is much less than their gross sales.

It may be said that this combines the activities of a thousand U.S. companies operating in a hundred foreign countries and that for this reason it exaggerates the impact on the economies of individual countries. In a broad sense there is some merit in this argument; but if we consider key industries and key countries, it is by no means a distorted view. Most U.S. companies that have foreign branches or subsidiaries are large-scale enterprises-not only in this country but abroad. This is not surprising, as it is in the field of mass production, the use of automatic equipment, that American business is most efficient and most profitable. The consequence of this, however, is that, in manufacturing, U.S. companies abroad are concentrated in the most modern, the most strategic, the most rapidly growing sectors of the foreign economy. Three large American companies dominate the automobile industry abroad, even in some of the large industrial countries; the sales of their foreign affiliates amounted to $9.5 billion in 1964 and must have been well over $10 billion last year. In Western Europe, U.S. companies have a virtual monopoly in producing sophisticated business machines.

II. REGIONAL AND INDUSTRIAL DISTRIBUTION OF U.S. DIRECT

(in billions of dollars)

Mining and Country or Region Total Manufacturing Petroleum Smelting Trade Other

In many less developed countries, enterprises involving the development of natural resources are almost all foreign-owned, mainly American. In some of these countries, foreign companies producing petroleum and minerals are the only enterprises using modern methods of production. In Canada the major sectors of the economy are foreign-owned to an unusual degree. In terms of capital employed at the end of 1963, the proportion of foreign investment was about 54 percent in manufacturing, 64 percent in petroleum and natural gas, and about 62 percent in mining and smelting; and seven-eighths of the foreign ownership was American. This explains why so many Canadians are preoccupied with foreign ownership of key sectors of their economy. It explains why foreign direct investment is not merely an economic but also a political problem.

To put the discussion in perspective, however, several points need to be made. First, U.S. companies have made and are making an enormous contribution to the economy of the countries in which they have direct investments. They operate efficiently, pay high wages, bear a fair share of taxes and make a large contribution to exports. Furthermore, they are a continuing source of technical know-how for their branches and subsidiaries abroad. In many instances, a country could not have developed a particular major industry if one or more American companies had not created the market, produced the goods and assumed the risks of investment.

Second, our direct investments abroad have been profitable to the companies concerned and have contributed to the basic strength of our balance of payments. Remitted earnings on direct investment amounted to about $4 billion in 1966, apart from the billion dollars paid by branches and subsidiaries of U.S. companies in royalties and licensing fees. Even now, when new funds going into direct investment are near the peak, the amount is substantially less than remitted earnings, as the table on the next page shows. Furthermore, foreign branches and subsidiaries of U.S. companies are good customers for our exports. While foreign affiliates may to some extent compete with their parents in export markets in third countries, it is by no means clear that this displaces American exports that would otherwise have been made.

Third, U.S. direct investments are on the whole conducive to maintaining a balanced pattern of international payments. Except in Europe, U.S. receipts of income and royalties and fees from direct investment are equal to or in excess of the new funds going into direct investment. While direct investment in Europe is a relatively large burden on our balance of payments, the situation may be reversed in a few years. In the meantime, the strain is relieved by the fact that a considerable part of the funds used by U.S. companies for direct investment in Europe is raised abroad. In Canada, Australia, New Zealand and South Africa, income from direct investments, including fees and royalties, is about equal to new funds going into direct investment. In the rest of the world, largely the less developed countries, receipts from direct investments, mainly in petroleum and mining, far exceed new funds going into direct investment. This does not, however, hurt the balance of payments of these countries, for the output of U.S. foreign enterprises there is almost all exported, and provides the foreign exchange necessary to pay for imports as well as remitted profits.

III. NEW DIRECT INVESTMENT AND RECEIPTS FROM U.S. FOREIGN ENTERPRISES, 1965- 66

a Does not include capital raised abroad. Source: Survey of Current Business, March 1967, p. 26-31.

In view of the mutual advantages derived from U.S. direct investment abroad, it may be asked why there should now be so much concern about it. The answer is that direct investment has social and political, as well as economic, aspects. In truth, most countries are ambivalent in their attitude toward U.S. direct investment. They want American industry but not on the scale or scope of the direct investment of recent years. No country wants to see its basic industries controlled by foreigners-even by efficient and friendly foreigners. The social and political ramifications of foreign control over large segments of the economy affect investors, businessmen and technicians, competing firms, the banking and financial markets, and even the foreign policy of a country.

III

The very fact that U.S. enterprises abroad are so large and so successful has generated a resurgence of economic nationalism-a mixture of mercantilist protectionism with political overtones. Local businessmen often feel that they are being excluded from the most profitable growth sectors of the economy because they cannot compete. Indeed, the competitive gap tends to become wider because U.S. companies have access to the research and development of their parent firms in the United States. How would American businessmen feel if they were deprived of the principal role in supplying the United States with automobiles, computers, data processing equipment and a long line of new products being steadily introduced from abroad? Can we doubt they would feel that they were being condemned to the traditional, often static, industries which are growing at a slow rate and in which profit opportunities are very limited?

Because U.S. enterprises abroad are almost all wholly owned by the parent company, investors have no opportunity to buy stock in some of the most successful companies in their own country. A German who wants to invest in the leading company in the German oil industry has to buy Standard Oil of New Jersey. A Canadian who wants to invest in the leading company in the Canadian computer industry has to buy International Business Machines. An Australian who wants to buy shares in the leading company in the Australian automobile industry has to buy General Motors. These are excellent companies and investors all over the world have done well with their shares. But they are U.S. companies, not German, Canadian or Australian companies. Foreign investors in such enterprises can have only a miniscule voice in determining the policies of these companies in their own countries.

The size and success of U.S. foreign enterprises make it possible for them to absorb a more-than-proportionate share of the scarce resources for investment. In 1966, American companies spent about $9.2 billion on new plant and equipment for their foreign branches and subsidiaries. About $3.6 billion of this was in Europe. In this major industrial region, economic policy in 1966 was designed to restrain the growth of investment in order to resist inflation. And yet, American expenditures for new plant and equipment in Europe were 34 percent higher in 1966 than in the previous year. These investments intensified the inflationary pressures and necessitated severe restriction on investment by domestic enterprises.

One aspect of the restraint imposed on investment in Europe in 1966 was the very tight credit policy. For various reasons, this had less effect on American than on domestic companies. Like all businesses at home and abroad, U.S. foreign enterprises finance a large part of their new investment out of retained earnings and depreciation and depletion allowances, as well as new funds sent from the United States. But they also depend on money borrowed in foreign markets. Because of the U.S. guidelines on direct investment, American companies in the past two years have depended to an unusual degree on borrowing in Europe, causing local firms to feel that they were being shut out. The fact is that U.S. companies have an astonishing facility for raising money abroad. In 1965 the total was $3.6 billion, as compared to $2.5 billion in new funds transferred from the United States. American firms are very good risks, and when their foreign bonds are denominated in dollars, guaranteed by the parent company and in some instances convertible into stock, very few domestic enterprises can compete with them in the European capital markets. U.S. companies floated about $800 million in dollar bonds in Europe in 1965 and 1966.

There is another aspect of the problem that is of great psychological importance. Even when U.S. enterprises abroad are headed by nationals of the host country, these executives seldom have the responsibility associated with their position. While the head of a branch or subsidiary may have final operating responsibility, the basic decisions on investment for expansion are made in New York, Chicago, Boston or Detroit. Actually, the chief executive officer of a foreign enterprise is quite often the man at the home office (or U.S. holding company) who is in charge of foreign operations. Thus, the responsibility of a foreign national, nominally the head of a U.S. branch or subsidiary, is distinctly inferior to that of the head of a domestic company.

Much the same may be said of the scientists and technicians employed by U.S. enterprises abroad. As noted, these companies are to a large extent concentrated in the new and rapidly growing industries which are most conscious of the importance of research. Unfortunately, in many instances the research is done almost entirely in company laboratories in the United States. Technical information is provided for the subsidiaries at secondhand. This cuts off foreign scientists and technicians from the best opportunities for industrial research in their own countries. In fact, the problem is one of national concern. If foreign countries do not independently conduct research and development, they will suffer from technological retardation that will seriously affect their economies.

The political problems that arise from U.S. domination of major economic sectors of foreign countries may be even more serious. An American company with direct investments in a foreign country is subject to the laws of the United States as well as those of the country in which it operates. It has, therefore, a dual loyalty. Under the Trading with the Enemy Act, the United States has placed an embargo on exports to Communist China, North Korea, North Viet Nam and Cuba. An American corporation in Canada would be violating U.S. law if it exported to these countries. On the other hand, Canada has no embargo on trade with these countries, except in strategic goods on the agreed NATO list. The decision of Canadian branches or subsidiaries of U.S. companies not to export to these countries is opposed to Canadian foreign policy, impairs the country's balance of payments, and holds down production, employment and income. Is it any wonder that some Canadians say they are no longer masters in their own economic house?

Our own balance-of-payments difficulties have aggravated the problems of other countries. As a result of the Administration's guidelines designed to limit the flow of new funds into direct investment abroad, many countries in Europe feel that they are financing the take-over of their own industries by U.S. companies, either because the funds for such expansion come from their own nationals or because their monetary authorities feel obliged to hold more dollars than they want as a result of our payments deficit. In other countries, where the expansion of American enterprises is essential to development, U.S. companies are urged by their Government to step up the remittance of profits, to export more to their foreign affiliates and to import less from them. Is it any wonder that some Australians say that the guidelines for U.S. companies have the effect of improving our balance of payments by worsening theirs?

We pride ourselves on the contribution that large U.S. companies have made through direct investment to economic development in Latin America, Asia and Africa. There is no doubt that they have done much to bring modern methods of production to countries in these areas. But in many, and perhaps in most, instances, the enterprises are managed by Americans and decisions on all major questions are made by the directors in the United States. Too often, the U.S. branches and subsidiaries constitute a sort of technological enclave-foreign-owned, foreign-managed and foreign-directed- in an economy that remains essentially primitive. Is it any wonder that some less developed countries believe that these enterprises have done less than they could or should to foster domestic enterprise, domestic technical development and a broad and balanced industrial economy?

These are the criticisms with which American business and Government are confronted in connection with direct investment abroad. Unfortunately, it is not sufficient to answer the critics by saying that our companies meet all the legal requirements of the host country and that the production and employment standards they set are enlightened and far in advance of local firms. Other countries know all this. They want the industries that foreign investment has brought to them. But they also want to integrate them with their own economies. They want the business policies of U.S. branches and subsidiaries to be in harmony with national economic, social and political objectives. They want enterprises capable not only of producing and selling but also of doing research, in collaboration with the parent companies abroad. They want their own nationals to participate in the ownership, to provide executives and technicians and to have a significant say in the direction of foreign-owned enterprises. These countries are not asking too much, and they will not be satisfied with less.

There is no easy answer to these problems. It is futile to appeal to traditional economic theory, to recall historic friendships and alliances, or to expect gratitude for economic and military aid, past or present. The policies of sovereign nations are governed not by sentiment but by national interest. If our business firms and our Government recognize this, it may be possible to solve the economic, social and political problems involved, for our national interests and those of other countries are not irreconcilable. It will take farsighted statesmanship and sympathetic understanding on both sides, but it can be done.

IV

The greater the extent to which U.S. companies dominate the economy of foreign countries, the greater will be the fear and resentment to which they give rise. If foreign governments believe that the operations of U.S. enterprises place pressure on their economic and foreign policies, they will inevitably decide to exert counter-pressure to neutralize the dominance of American firms. Such a game of pressure and counter-pressure cannot be in the long-run interests of either country. If the United States adopts policies designed to permit private companies to assume and retain a dominant role in the economies of unwilling hosts, it will encounter resistance that will inevitably spread from the economic to the diplomatic sphere.

New funds going into American direct investment abroad have nearly doubled in the past five years-most of them concentrated in manufacturing in Western Europe. A period of consolidation is now in order. While it is not possible for established enterprises to avoid continued growth in their foreign investments if they are to retain their market position, a moratorium should be declared on expansion into new fields, and particularly on buying up existing companies. Such a period of consolidation would reassure Europe that its economy will not become a satellite of American industry, and might moderate, although it would not end, the criticism that U.S. companies are encountering abroad.

The United States cannot, of course, be indifferent to the interest of its investors abroad. They have a right to look to their Government for protection and the Government has a duty to provide such protection within the limits of its foreign policy. But here a distinction can be made between new investments and old investments. The United States should not oppose measures by other countries that would restrict the entry of new foreign firms into specified sectors of the national economy, but it can urge that such measures avoid discriminating against U.S. companies. In low- income countries, foreign investment obviously can be helpful to economic development. As a generous donor of aid, it is not inappropriate for the U.S. Government to point this out. But it must be objective in urging this view and it must not be a sponsor of particular enterprises, however helpful the proposed investments would be to the economies of these countries.

Where foreign governments place restrictions on existing U.S. investments, the proper role of diplomacy is more difficult to define. Obviously, it is inappropriate to oppose reasonable regulations considered necessary for the domestic economy-say, restrictions on remittances of profits for balance-of- payments reasons-provided they are nondiscriminatory. As for the nationalization of U.S. enterprises, there should be clear evidence that it is nondiscriminatory and that adequate compensation will be promptly paid. The problem is more difficult where foreign enterprises are required to divest themselves of a large share of their ownership (say, 50 percent) to nationals of the host country, and they should be given adequate time to find acceptable partners and to negotiate a fair price for the share of their business that they must sell.

Ideally, disputes between governments and foreign investors should be settled on economic, not political, grounds. The World Bank has sponsored a multilateral Convention on the Settlement of International Investment Disputes which provides machinery for conciliation and, where agreed to, for arbitration. As the Legal Adviser of the State Department said in a written statement to the Senate Foreign Relations Committee, this "mechanism for impartial resolution of any disputes between investors and host governments is a meaningful step toward assuring fair treatment for investor and host country alike." It is to be hoped that many more countries will eventually subscribe to the convention. Where a dispute arises with a country that is not a party to the convention, there is little the United States can do beyond pointing out that unfair treatment of U.S. investors will interfere with the maintenance of the best economic relations between the two countries. The exercise of diplomatic pressure for the benefit of U.S. companies may create serious resentment and merely worsen the investment climate.

In any event, it would be unfortunate if the position of American business abroad were to become dependent on diplomatic pressure from Washington. Ultimately, U.S. companies must adapt themselves to the conditions that confront them abroad; and it would be the highest statesmanship if they took the lead in setting appropriate standards for their operations in foreign countries. First, we must accept the premise that U.S. business-no matter how efficient, no matter how productive-cannot expect to dominate the economy of any country, whether highly industrialized or underdeveloped. Second, we must accept the premise that foreign countries should have access to our technical knowledge without being required to accept domination of their basic industries to acquire it. Third, we must accept the premise that foreign investors, foreign executives and foreign directors have a right to participate in the ownership, management and control of U.S. companies operating in their countries.

Once these premises are accepted, the practical solution becomes evident. No U.S. company should control all or nearly all of a basic industry in a foreign country if any part of the business can be done by local firms. Instead of shutting out competition, our companies should help to establish it. Whenever strategic considerations do not prevent it, U.S. companies should enter into licensing agreements for the use of their patents and technical processes by domestic companies in the countries in which they operate. Such a policy is, after all, much the same as they are required to follow in the United States under the antitrust laws. Even this would not assure other countries the broad and steady technical development that is essential for economic progress. Actually, there is no substitute for a do- it-yourself program in research and development; and foreign countries should help their own companies to coöperate in such work. Europe has been very successful with multinational economic coöperation; similar coöperation in research and development should be possible in key industries.

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Local investors in foreign countries should be encouraged to buy shares in the subsidiaries of U.S. companies abroad. There are, to be sure, practical difficulties. In some instances, all or a very large part of the earnings must be retained for the growth of the business, so that dividends, if any, may be small for some years. This might make it difficult to sell the shares at a fair price. Other problems may arise where subsidiaries in different countries have close working relations, so that the allocation of profits between them is determined more or less by accounting rule-of- thumb. A possible solution is to form a holding company, say, for all European subsidiaries of a particular firm, with shares of the holding company offered for sale in the countries in which the subsidiaries operate. It is interesting to note that Dow Chemical Company and Swift & Company have jointly established an Australian company which will offer equity participation to local institutional investors. After the venture is operating on a profitable basis, the shares may be publicly traded.

Finally, U.S. companies abroad should conduct their operations in complete harmony with the political, economic and social objectives of the host country. For the U.S. Government this would require a self-denying policy on the use of the Trading with the Enemy Act to control the operations of foreign branches and subsidiaries, except in time of emergency. For U.S. companies, this would require that some of the principal executive officers and directors be nationals of the host country. The participation of foreign nationals in management and control should be more than nominal. It would defeat the purpose of such a policy if the officers and directors of a foreign subsidiary were no more than local agents carrying out directives from the head office in the United States. Needless to say, such officers and directors would have the duty of operating the company in the interests of the shareholders-a duty inherent in all corporate management. In the long run, U.S. companies will be better off if they recognize that their foreign subsidiaries have the same responsibility for achieving the economic, social and political objectives of the host country as do American companies operating in the United States.

Such a policy on direct investment requires great foresight and restraint by U.S. companies. In the long run, it is the only tenable policy because it is in accord with the economic interest of business and the national interest of both the United States and foreign countries. The overwhelming economic power of the United States is shown by the fact that some of our giant companies are larger than the entire economies of small but highly industrialized countries like Belgium and the Netherlands; they are incomparably larger than the entire economies of nearly all of the less developed countries. Economic power of this magnitude carries with it equivalent responsibility. If our companies use their power with consideration for the well-being of other countries, as well as for our own, they can be of tremendous help in creating a prosperous world economy employing modern methods of production. Otherwise, their economic power will be a constant irritant in our diplomatic relations with the rest of the world and will ultimately defeat their own interests.